Giving Your Child a Leg Up on Retirement With an IRA

According to the U.S. Census Bureau, only 32 percent of people in the United States have a 401K and are prepared for retirement.

The reasons why vary. Some don’t have access to a plan through their employer, some can’t afford to contribute, and others don’t know how to go about it. An Individual Retirement Account, or IRA, is a valuable tool that many Americans use outside of a 401K. But have you ever considered opening one for you child?

Although college savings is the priority for most parents, opening an IRA can be a great way to teach your child about saving and get them prepared for retirement.

How Does it Work?

The main requirement for opening an IRA is income. Your child may not have a full-time job, but they can deposit money earned from after-school jobs, babysitting, and even proceeds from a YouTube channel. Most financial institutions won’t allow minors to open brokerage accounts, but parents can open a custodial account that will transition to the child's ownership when they turn 18. A financial planner can help you decide how to open and structure an account.

IRA vs. Roth IRA

A traditional IRA is funded from pre-tax earnings, and tax is paid when you withdraw the money at retirement. Contributions to an IRA can also be deducted on your annual taxes. Roth IRAs are funded with post-tax contributions. Tatyanna Bunich, a wealth planner at Financial 1 Wealth Management Group in Columbia, Maryland, suggests choosing a Roth IRA over an IRA for your child.

“Most likely your child won’t be earning enough to pay income taxes, so a Roth IRA is the best choice. The money will build over time and your child won’t pay any tax on the withdrawal,” she says.

The maximum contribution for a Roth IRA as of 2018 is $5,500 per year. IRA deposits must match up against wages and income from a W-2 or 1099 IRS form. If your child has earned more than $400 without receiving these forms, you should consult a tax professional.

Getting Your Child to Participate

The biggest challenge of a kid-funded IRA is getting them to fund it. Children and teenagers live in the now and would rather spend their earnings on clothes, electronics, and entertainment. You can encourage them to contribute by showing them projections of how the account can build over time. You could also be sneaky (and generous) by offering to give them spending money equal to the amount they put in their account.

Have you opened an IRA or another type of savings account for your child? Tell us in the comments below!